Govt Signals Shift Toward Sustainable, Contributory Pension Framework

The Union Cabinet, chaired by Prime Minister Narendra Modi, approved the Terms of Reference (ToR) of the 8th Central Pay Commission recently, which explicitly includes addressing the unfunded cost of non-contributory pension schemes. This means the Commission must evaluate the financial burden on the government of paying pensions to retirees without any prior contributions from them or their employers into a dedicated pension fund.

The government has, thus, indicated that it does not intend to revert to an unfunded and non-contributory pension model. This suggests a clear policy direction away from solely bearing pension liabilities as unfunded commitments from the general budget, according to financial experts.

In essence, the government is likely aiming to adopt a more sustainable pension approach, possibly favouring contributory or partially funded pension schemes. This would reduce the unfunded liabilities by sharing pension funding responsibilities between the government and employees, ensuring fiscal prudence while still providing adequate retirement benefits. Such a shift would help manage the growing pension burden on the exchequer and make pension schemes financially sustainable in the long run.

What Is An Unfunded Non-Contributory Pension Scheme?

In India, the Old Pension Scheme (OPS), which was in place before 2004, is an example of an unfunded, non-contributory pension. Under this scheme, retirees receive a pension directly from the government's current revenues, without having contributed to a pension fund during their service.​ The government bears the entire cost, and there is no reserve or corpus built up to meet future pension liabilities. This creates a direct and growing fiscal burden, especially as the number of retirees increases.​

Why Is the Government Focusing on This?

The government is concerned about the long-term sustainability of pension payments, as the unfunded nature of the OPS means that pension expenses are met from the annual budget, competing with funds for development and welfare.​

The inclusion of this phrase in the Terms of Reference signals that the government wants the Pay Commission to recommend changes that could reduce the fiscal stress caused by these pension liabilities, possibly by discouraging a return to the OPS and instead promoting contributory schemes like the National Pension System (NPS).

Shift Towards A Contributory Model

Financial planners say the government’s inclusion of unfunded liability of the non-contributory pension scheme in the terms of reference for the 8th Central Pay Commission clearly signals that a return to the old non-contributory scheme is off the table.

“That is sensible for any government which is focused on fiscal prudence of the economy. As human longevity increases and retirements extend, unfunded pension burdens grow rapidly — indeed, a study done just one year back finds that reverting to the old defined-benefit scheme would raise states’ pension liabilities by up to 4½ times compared to the current contributory model,” says Col Sanjeev Govila (Retd), Certified Financial Planner, CEO, Hum Fauji Initiatives, a financial advisory firm.

The Union government is cognizant of the fact that a return to the unfunded and non-contributory Old Pension Scheme (OPS) could be fiscally imprudent; hence, it does not want to revert to it.

“That is the reason the NPS or the UPS was introduced. Now, the Union Government has tried to close a backdoor to OPS by including it in the Terms of Reference (ToR) while setting up the 8th Pay Commission, so that its recommendations would address this issue. The Union Government wants to ensure that pension sustainability rests on individual employee investment decisions and financial discipline, rather than on government guarantees,” says Abhishek Kumar, Founder at SahajMoney.

While the call from employees for the guaranteed pension under the old scheme is understandable, any responsible government must weigh fiscal sustainability.

“The shift towards a contributory model ensures sharing of risk and creates a corpus, rather than piling up pay-as-you-go liabilities which may even become difficult for governments to pay. Thus, while employee concerns merit respect, the long-term fiscal health of the country demands a pension architecture founded on sustainability,” says Govila. According to him, a well-designed contributory scheme, combined with adequate safeguards for retirees, rather than a full reversion to the old model should be the preferred way forward.